Malaysia: Commercial Aircraft: The New Buzz Within The Islamic Finance Community

Last Updated: 9 November 2017
Article by Labuan IBFC Inc.

Article by Dean Argent

This article discusses how Islamic Finance is being deployed to finance the acquisition of Airliners (such as Boeing and Airbus aircraft) that are placed under long-term leases. This High Yielding Alternative Investment Class is the new buzz within the Islamic Finance community.

As a result of the Global Financial Crisis and Eurocrisis, conventional aircraft financing sources have dried up for now. But with its long-term predictable income, growth forecasts and suitability for Islamic Financing, an immense market opportunity now exists for savvy Islamic Finance investors.

Islamic finance is growing fast. Over the next decade, the Islamic Capital Markets is expected to sustain double-digit growth to almost USD1 trillion in 2020 with CAGR of 10.6%. In 2000, there were MYR39.6 billion in Sukuk issues. In 2010 it had grown to MYR294 billion and the Malaysian Securities Commission expects further growth to a staggering MYR1331.5 billion by 2020.

The Sukuk market has been quite resilient during recent instability in global financial markets which is making conventional bond issues difficult. The resilience is a result of the Islamic investors remaining cash rich; partly due to limited supply of Sukuk; and partly since Sukuk investors tend to hold the bonds until maturity, reducing the chance of big swings in secondary market prices triggered by shorter-term speculators bailing out of positions.

No matter what the reason, Aircraft Lessors are now turning to Islamic financing to support their aircraft acquisitions and those lessors backed by Islamic Finance are growing at astronomical rates.

The aircraft leasing industry is relatively new, with the first aircraft lease recorded in the 70's. Now, around 40% of the world's aircrafts are leased. According to Boeing, 35% of the USD4.5 trillion in new aircraft deliveries over the next 20 years will be delivered to Asia – which is the global number 1 hotspot for aviation growth.

Couple this immense market opportunity with the emergence of Labuan as one of the most competitive jurisdictions in the Asia Pacific region – along with aircrafts' compatibility with Islamic Financing methods - and you have the making of the next explosive growth industry.

Despite its recent rapid rise in popularity, Islamic financing for aircraft transactions have been around for a while, here's just a sample of some large Islamic Finance transactions:

  • In 2005, Emirates issued a USD550 million Sukuk bond and repaid it in full during June 2012.
  • In 2008, Etihad won airfinance journal's deal of the year for an Airbus A340-600 purchase from Airbus supported by Islamic finance (circa USD140 million).
  • In November 2009, GE sold USD500 million in Sukuk against existing aircraft.
  • In July 2010, Nomura sold USD100 million in Sukuk against existing aircraft.
  • In June 2012, the Malaysian Finance Ministry sold MYR5.3 billion of Islamic bonds to finance 6 x Airbus A380s and 2 x Airbus A330s for lease to Malaysian Airlines.
  • In June 2012, Malaysian Airlines sold MYR1 billion of Islamic bonds.
  • In September 2012, Malaysian Airlines sold a further MYR500 million of Islamic Bonds.
  • In October 2012, Turkish Airlines is well progressed in a multi billion Sukuk issue to finance the purchase of aircraft to double its fleet over the next 10 years.

Alafco, the aircraft leasing arm of Kuwait Finance House, employs Islamic Finance techniques to acquire their aircraft fleet. It is one of the fastest growing aircraft leasing companies in the world. In 2011, it had 105 firm orders with Boeing and Airbus – the second largest order book of all lessors on the planet.

Media reports are commonplace describing Dubai's Emirates airline investigation of Islamic Financing to fund their aircraft deliveries in the wake of the Eurozone Crisis. Malaysian Airlines is at the forefront of innovation in the Islamic Capital Markets when they were the first ever corporate issuer of a Perpetual Sukuk in June this year. The MYR2.5 billion programme was fully subscribed, with the first subscriber at MYR1 billion.

The proof is irrefutable. Islamic Financing as a method of acquiring commercial aircraft is the fastest growing financing method in the industry, and it's growing exponentially.

The power houses of the Asian banking sector are on a mission to internationalise Islamic Financing. In Bank Negara Malaysia's Financial Sector Blueprint 2011- 2020, the key recommendations regarding Internationalisation of Islamic Finance are as follows:

  • Increase the diversity of players in the domestic Islamic financial industry to support a wider range of financial products and services that serves the best interest of Malaysia.
  • Support the growth of the Islamic fund and wealth management industry in collaboration with relevant authorities.
  • Enhance the dynamics of the Islamic money, foreign exchange and capital markets.
  • Increase market efficiency by facilitating the use of standard documents and agreements among financial market players.
  • Promote active participation in issuance and trading of Sukuk.

So the stage is set. The timing is right, the place is Labuan and investments in Commercial Aircraft as an alternative asset class is rapidly growing.

But there are some restrictions. Islamic finance must comply with various requirements of the Shariah including the prohibition on Riba (which includes interest). And there are some major transactional structure differences between financing leased aircraft with Conventional Finance vs Islamic Finance. The end result however, is the same, that is, the lessee ends up with the right to quiet enjoyment of the aircraft for the agreed period and the economic responsibility of the asset is passed to the lessee for the lease term.

Under conventional financing methods, the lessee pays a monthly rental fee in advance plus, it also pays Maintenance Reserve payments to compensate the lessor for the maintenance utility consumed by the lessee. But to achieve compliance with Shariah, the transaction must be structured differently so that the lessor remains responsible for major and structural maintenance, hull and equipment and ownership taxes. But airlines are in the business of operating aircraft and they must have a maintenance capability. Conversely the financier/lessor is not normally in the business of operating or maintaining aircraft, so it is common for the lessor to appoint the airline/lessee as its service agent to complete and fund for those expenses.

The lessor as principal must repay those costs to the Lessee/service agent, and the rental payments are increased accordingly. But, these payment obligations and the extra rent are offset against each other and this effectively passes the economic responsibility of the aircraft to the lessee.

Risk mitigation

To protect the Islamic financier from the inherent risks that come with ownership of a financed asset, a Special Purpose Vehicle (SPV) can hold the aircraft subject to a Mudaraba (an investment management agreement) and the SPV becomes the Mudarib (the investment manager) and the financier becomes the Rabb-ul-maal.

Under the Mudaraba financing model, the investors pass their funds to the Mudarib for it to use in accordance with the investment plan. The Mudarib must have a share of profits (which can be small) and will not be responsible for losses unless caused by its negligence or default. While the legal nature of a Mudaraba must be tested under local law, interposing the Mudarib as the lessor and legal owner of the aircraft can create some distance between the Islamic financiers and ownership risks.

Features of Islamic financing of commercial aircraft

Diversification of funding sources. Until recently, Islamic Financing has not been considered a mainstream alternative to conventional finance. Coupled with conventional-style documentation, bankable governing law, the ability to combine with conventional funding sources and a new market has opened up.

Sukuk holders are investors not creditors. The relationship of Sukuk holders to issuer is that of investor, not creditor. The Sukuk holders are joint owners of trust assets, being aircraft (subject to leases), the lease revenues and lease rights. They exercise their rights as owners through a Sukuk agent, who has the authority to enforce lease rights, and can be compelled to do so by relevant proportion of Sukuk holders.

The Sukuk holders' rights against the Issuer are limited in recourse to the trust assets – normally being the aircraft itself. The complexity of each transaction is dictated by the investor/rating requirements. For example rating agencies such as Standard Poor's, Moody's, Fitch apply conventional rating criteria, to which Shariah compliance is not relevant. This allows minimal reliance of the performance of Ijarah because the rating agency is more likely to focus on other issues such as level of over-collateralisation, bankruptcy protection, quality of the asset and its liquidity.

Under Islamic Financing arrangements, the standard ingredients include Aircraft Management and Remarketing Agreements, removal of the lessor from other transactions for bankruptcy remoteness and establishment of the lessor in a tax-friendly jurisdiction.

Aircraft lessors' requirement for Islamic Funding seems likely to outstrip conventional funding sources available due to huge aircraft orders and need for specialised appetite for regional risk. The recent run of innovative Islamic aircraft financings have helped develop Islamic aircraft financing technology, while non-airline sukuks and airline bonds have established investor appetite for this asset class.

If you are seeking long-term predictable returns – without correlation to the equities markets – then investing commercial aircraft using Islamic Financing could be right for you.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
Some comments from our readers…
“The articles are extremely timely and highly applicable”
“I often find critical information not available elsewhere”
“As in-house counsel, Mondaq’s service is of great value”

Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Emails

From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

*** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.